- Low oil prices have pushed the economy into a renewed recession.
- The weak ruble implies that pace of disinflation will slow.
- This will delay the CBR’s easing cycle.
- Economy to shrink by 0.5% in 2016, before growing modestly in 2017.
Low oil prices have pushed the economy into a renewed recession
The renewed fall in oil prices that we have seen since the end of last year has started to weigh on the Russian economy. ABN AMRO now expects an average Brent oil price of $50 per dollar for this year. This compares to our earlier forecast of $65 and an average oil price of $53.5 in 2015. A lower oil price reduces the value of the ruble, which in turn drives up inflation. This reduces the real purchasing power of households, firms and the government. Lower oil revenues also imply that there are less spill over effects from the oil sector to the other sectors of the economy. This explains why after the economy showed signs of stabilisation in the third quarter of last year, we have seen a renewed deterioration of the activity data at the end of last year. For instance, real retail sales fell by 15.3% yoy in December, down from the -13.1% that was recorded in November and the –11.7% seen in October. There was also a renewed weakness in investment, which fell by almost 9% in December, the weakest number since 2009, while the fall in industrial production also intensified. All this means that there was a considerable loss of momentum, and that the economy most likely fell into a renewed modest recession at around the turn of the year.
Weak ruble slows the pace of disinflation
The weak ruble will also affect monetary policy. Although inflation has started to come down, as the effects on import prices of the ruble weakness at the end of 2014 are starting to fall out of the annual comparison, price gains have started to rise at a faster pace again in month-on-month terms. In December, consumer prices jumped by 0.8% mom, following a 0.7% rise the month before. In contrast, in August, during a period of relative ruble stability, monthly price gains were just 0.3%. All this risks that inflation expectations become dislodged. In turn, this will make it more difficult for the central bank of Russia (CBR) to resume its easing cycle. The central bank was forced to hike rates all the way to 17% to contain the financial crisis at the end of 2014. Last year, in steps, it lowered its key policy rate to 11%. However, it has kept rates constant since August of last year. It fears that a new set of rate reductions to underpin the weak economy could spur further ruble weakness and hence underpin inflation. As a result of all this, we think that the CBR will refrain from lowering rates during its March meeting. However, we think that oil prices are close to finding a bottom. This should lead to some modest ruble appreciation going forward, and in its slipstream a slower pace of monthly price gains. As a result, we think that the CBR will reduce its key rate by 50bp in June, September and December of this year. This would bring the policy rate to 9.5% at year end, implying that financial conditions will remain tighter this year than earlier thought. Moreover, given recent developments in oil prices, there is clearly a risk that these will remain lower for longer, which would make it even harder for the CBR to ease policy.
Lower oil prices also weigh on government finances
As roughly half of the government’s revenues stem energy exports, a lower oil price also weighs on government finances. The effect on the budget of the drop in oil prices will only be partially offset by the weaker ruble. This is because oil prices have fallen at a faster pace than the ruble has weakened (what matters for the Russian government are oil export revenue expressed in rubles rather than in dollars). As a result, federal budget revenues fell from 14.5 trillion ruble to 13.6 trillion ruble in 2015, according to the Ministry of Finance. In contrast, government expenditures inched higher in 2015, rising from 14.9 trillion ruble to 15.9 trillion ruble. As a result, the fiscal deficit rose from 0.5% of GDP to 2.6% of GDP. According to the 2016 budget, government expenditures should remain broadly unchanged, totalling 16.1 trillion ruble, though – given the sharp rise in inflation – this presents a significantly lower amount in real terms. Revenues, meanwhile, are being seen at 13.7 trillion ruble, again broadly unchanged. This should lead to a deficit of 3% of GDP, slightly higher than the deficit of last year. The government’s budget is based on an average oil price forecast of $50 dollar per barrel. However, given recent oil price movements the risks of a larger deficit are tilted to the upside. Indeed, the government recently announced plans to trim government spending by 10% across some departments, though these have not been formalised.
Government to tab its Reserve Fund – but fiscal position still relatively healthy
At any rate, Russia has started to tab its Reserve Fund to finance its fiscal deficits. Assets under management steadily declined from $92bn in August of 2014 to $50bn at the end of last year. However, while it is clear that Russia has less fiscal leeway than during the global financial crisis, it is important to realise that Russia’s fiscal position still remains relatively healthy. In 2015, Russia’s debt-to-GDP ratio was just 14%, and partly as a result from Reserve Fund withdrawals we only expect to see a modest rise in Russia’s debt in coming years. A modest rise in oil prices in coming years should also alleviate pressure on Russia’s fiscal parameters. The upshot is that while it is clear that the low oil price is putting a strain on the economy, the fiscal situation is likely to remain manageable given our price scenario.
External side of the economy unaffected
The external side of Russia’s economy is also likely to remain healthy. While a lower oil price will reduce export earnings, the weak economic backdrop will keep a lid on imports. The result will be that the current account should remain comfortably in surplus this year. Meanwhile, Russia’s FX reserves, after having fallen sharply in the second half of 2014 and the beginning of 2015, have stabilised at around $320bn, which covers more than 10 months of imports. Finally, while rising, external debt is also relatively low.
Economy to shrink by 0.5% this year
Bringing everything together, we now expect the economy to shrink this year by 0.5%. This compares to our previous forecast of a 0.5% expansion this year. As the weakness was concentrated in the final months of last year, and as there will be more economic softness in the beginning of this year, the effects on our average GDP growth forecast will be relatively pronounced. We stress though that we do not think that the magnitude of the recession will be as large as the recession seen during the end of 2014 and the beginning of 2015. Indeed, we expect a modest recovery in the second half of this year that should continue in 2017. This explains why we keep our 2017 GDP growth forecast unchanged at 1.5%. That said, the risks to our forecast are tilted to the downside. This reflects the large dependence of Russia’s economy on oil and that oil prices, so far, have remained weaker than we originally had thought.